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This article is written for those who want to get better at using price to earnings ratios (P/E ratios). To keep it practical, we’ll show how EDAG Engineering Group AG’s (FRA:ED4) P/E ratio could help you assess the value on offer. Based on the last twelve months, EDAG Engineering Group’s P/E ratio is 11.97. In other words, at today’s prices, investors are paying €11.97 for every €1 in prior year profit.
How Do I Calculate A Price To Earnings Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for EDAG Engineering Group:
P/E of 11.97 = €11.72 ÷ €0.98 (Based on the trailing twelve months to March 2019.)
Is A High Price-to-Earnings Ratio Good?
A higher P/E ratio means that buyers have to pay a higher price for each €1 the company has earned over the last year. That isn’t necessarily good or bad, but a high P/E implies relatively high expectations of what a company can achieve in the future.
How Growth Rates Impact P/E Ratios
Companies that shrink earnings per share quickly will rapidly decrease the ‘E’ in the equation. Therefore, even if you pay a low multiple of earnings now, that multiple will become higher in the future. So while a stock may look cheap based on past earnings, it could be expensive based on future earnings.
In the last year, EDAG Engineering Group grew EPS like Taylor Swift grew her fan base back in 2010; the 53% gain was both fast and well deserved. Unfortunately, earnings per share are down 70% a year, over 5 years.
Does EDAG Engineering Group Have A Relatively High Or Low P/E For Its Industry?
One good way to get a quick read on what market participants expect of a company is to look at its P/E ratio. The image below shows that EDAG Engineering Group has a lower P/E than the average (15.1) P/E for companies in the auto components industry.
Its relatively low P/E ratio indicates that EDAG Engineering Group shareholders think it will struggle to do as well as other companies in its industry classification.
Don’t Forget: The P/E Does Not Account For Debt or Bank Deposits
It’s important to note that the P/E ratio considers the market capitalization, not the enterprise value. In other words, it does not consider any debt or cash that the company may have on the balance sheet. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.
Spending on growth might be good or bad a few years later, but the point is that the P/E ratio does not account for the option (or lack thereof).
Is Debt Impacting EDAG Engineering Group’s P/E?
EDAG Engineering Group’s net debt equates to 27% of its market capitalization. You’d want to be aware of this fact, but it doesn’t bother us.
The Verdict On EDAG Engineering Group’s P/E Ratio
EDAG Engineering Group trades on a P/E ratio of 12, which is below the DE market average of 20. The company does have a little debt, and EPS growth was good last year. If the company can continue to grow earnings, then the current P/E may be unjustifiably low.
Investors have an opportunity when market expectations about a stock are wrong. As value investor Benjamin Graham famously said, ‘In the short run, the market is a voting machine but in the long run, it is a weighing machine.’ So this free visualization of the analyst consensus on future earnings could help you make the right decision about whether to buy, sell, or hold.
Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.
If you spot an error that warrants correction, please contact the editor at email@example.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.